CFTC Staff Letter 13-88: No-Action Relief for Production Payment Vehicles

Gary Barnett
Director
U.S. COMMODITY FUTURES TRADING COMMISSION
Three Lafayette Centre
1155 21st Street, NW, Washington, DC 20581
Telephone: (202) 418-5977
Facsimile: (202) 418-5407 gbarnett@cftc.gov
Division of Swap Dealer and Intermediary Oversight CFTC Letter No. 13-88 No-Action March 29, 2013 Division of Swap Dealer and Intermediary Oversight Re: “X” request for exemption of Production Payment Vehicles from commodity pool regulation Dear:
This letter is in response to your letter dated March 29, 2013, to the Division of Swap Dealer and Intermediary Oversight (the “Division”) of the Commodity Futures Trading Commission (the “Commission”), as well as additional email correspondence with Division staff. You request on behalf of “X” (collectively, “X”) confirmation that the Division would not recommend enforcement action against the commodity pool operator of “production payment vehicles” for failure to register as such. Based upon the representations in your letter, we understand the relevant facts to be as follows. Production payment vehicles are oil and gas financing structures used by U.S. oil and natural gas producers which execute swaps to hedge market risks of a physical production payment asset that they own. Because of the inclusion of swaps as a commodity interest within the definition of a commodity pool under Section 1a(10) of the Commodity Exchange Act, such vehicles may be classified as commodity pools. You describe production payment vehicles as special purpose entities that own passive, non￾operating, overriding royalty interests in oil and natural gas well production that entitle their owner to receive delivery of a certain volume or value of liquid or gaseous hydrocarbons, typically each month, for a specified period of time, determined without regard to production costs. Stated another way, the oil or natural gas company (the “Seller”) conveys the right to receive production from the subject wells that are identified in the conveyance up to an agreed upon volume. You state that the production payment vehicle issues debt or debt-like instruments, which are fixed income securities. You also state that the vehicle receives and immediately sells the hydrocarbons received by it each month under the production payment at a then-market price. You state that the transaction is structured so that the scheduled production volumes delivered will generate cash proceeds, based on the sale of production on or around each of the payment dates at prices derived from the forward curve in existence on the execution date of the assignment or conveyance, that provide an investment grade likelihood of being sufficient to repay the issued securities. Additionally, you state that you reach the investment grade likelihood of repayment sufficiency through applying a “period production coverage” to the production stream and a “tail coverage” such that